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Bureau of Mines Information Circular/1985 



A Summary of Current and Historical 

Federal Income Tax Treatment 

of Mineral Exploration 

and Development Expenditures 



By Phillip N. Yasnowsky 




UNITED STATES DEPARTMENT OF THE INTERIOR 



w 

c 

3) 

m 

> 
c 



^/NES 75TH AV'''^ 



V 



Information Circular 9011 



A Summary of Current and Historical 

Federal Income Tax Treatment 

of Mineral Exploration 

and Development Expenditures 



By Phillip N. Yasnowsky 




UNITED STATES DEPARTMENT OF THE INTERIOR 

Donald Paul Model, Secretary 

BUREAU OF MINES 
Robert C. Morton, Director 



.Hi- 




Library of Congress Cataloging in Publication Data: 



Yasnowsky, Phillip N 

A summary of current and historical federal income tax treatment of 
mineral exploration and development expenditures. 

(Bureau of Mines information circular ; 9011) 

Bibliography: p. 11-12. 

Supt. of Docs, no.: I 28.27:9011. 

1. Mines and mineral resources— Taxation — Law and legislation- 
United States. I. Title. II. Series: Information circular (United States. 
Bureau of Mines) ; 9011. 

-¥■109^0^4- [KF6495.M5] 622s [343.7305'21 84-600327 



CONTENTS 



Page 



Abs tract 

Introduction 

Exploration and development — definition of terms 

Current tax treatment of exploration and development expenditures 

Exploration expenditures 

Development expenditures 

Major changes in the Federal tax treatment of exploration and development 
expenditures 

Prior to 1951 



1951 
1954 
1960 
1966 
1969 
1976 
1982 



Public Law 183-82nd Congress (Revenue Act of 1951) 

Public Law 591, 83rd Congress (Internal Revenue Code Revision) 

Public Law 86-594 

Public Law 89-570 

Public Law 91-172 (Tax Reform Act of 1969) 

Public Law 94-455 (Tax Reform Act of 1976) 

Public Law 97-248 (Tax Equity and Fiscal Responsibility Act of 1982) 

Analysis of changes 

Summary and conclusions 

References 

Appendix. — Glossary 



1 
2 
3 
4 
4 
5 

6 

6 

6 

7 

7 

7 

8 

8 

8 

9 

10 

11 

13 



A SUMMARY OF CURRENT AND HISTORICAL FEDERAL INCOME TAX TREATMENT 
OF MINERAL EXPLORATION AND DEVELOPMENT EXPENDITURES 

By Phillip N. Yasnowsky ' 



ABSTRACT 

In this Bureau of Mines report, the Federal income tax treatment of 
mineral exploration and development expenditures is summarized, and 
changes in the tax treatment of these expenditures since 1951 are de- 
tailed and analyzed. Although no attempt is made to establish causal 
relationships, major tax changes favorable to exploration and develop- 
ment activities did occur in 1951 and 1966 when the Nation was engaged 
in military actions and the economy was expanding. More recent changes 
have been unfavorable to exploration and development and were parts of 
major tax reform efforts. 



^Economisr, Branch of Technical Analysis, Bureau of Mines, Washington, DC. 






INTRODUCTION 



This Bureau of Mines report discusses 
the Federal tax law provisions relating 
to mineral exploration and development 
expenditures. These provisions, con- 
tained mainly in sections 616 and 617 of 
the Internal Revenue Code of 1954 (Title 
26 of the U.S. Code), apply specifically 
to minerals (other than oil and gas) , and 
thus are of interest to the Bureau of 
Mines. 

Bureau of Mines involvement in this 
subject stems from the legislative man- 
date in the 1913 amendments to the Organ- 
ic Act of 1910 (the Act creating the 
Bureau) to conduct economic investiga- 
tions of the mineral industries. Con- 
gressional concern with the economic and 
financial conditions in the mineral in- 
dustries was expressed more recently in 
the Mining and Minerals Policy Act of 
1970 and in the National Materials and 
Minerals Policy, Research, and Develop- 
ment Act of 1980. The General Accounting 
Office recommended in 1976 that the De- 
partment of the Interior "identify and 
evaluate laws and agency programs that 
affect maintaining and developing a sound 
and stable domestic mining and minerals 
industry" ( 17 , p. iii).^ 

Taxes, a source of revenue to govern- 
ments, are a cost to private firms. 
Thus, taxes directly affect private sec- 
tor profits, and unique tax provisions 
are designed to encourage (or discourage) 
activities such as agriculture, construc- 
tion, or mining. Even the international 
competitiveness of the domestic mineral 
industries may be affected by taxes be- 
cause many minerals are traded in world 
markets. 

Recent major tax law changes and pro- 
posals for change emphasize the need for 
timely tax information. Changes in the 

^Underlined numbers in parentheses re- 
fer to items in the list of references 
preceding the appendix. 



tax law during the past few years include 
the Economic Recovery Tax Act of 1981, 
the Tax Equity and Fiscal Responsibility 
Act of 1982, and the Deficit Reduction 
Act of 1984. Major tax proposals in re- 
cent years include the consumption tax, 
the value-added tax, and the flat-rate 
tax. The current tax structure is ex- 
tremely complicated, and knowledge of its 
unique provisions is necessary if the 
effects of proposed changes are to be 
assessed. In this report, analysis of 
the changes in the tax treatment of ex- 
ploration and development costs since 
1951 shows how the current tax treatment 
has evolved. Of course, it would be un- 
wise to place too much emphasis on the 
analysis of specific tax provisions; ul- 
timately, it is the total tax system that 
must be evaluated on the basis of select- 
ed criteria. However, the analysis of 
specific provisions is more manageable, 
and these provisions reflect the special 
problems in taxation encountered in areas 
such as natural resources. 

This report is directed toward the gen-" 
eral reader and, consequently, does not 
cover all details of the tax law pertain- 
ing to exploration and development expen- 
ditures. The reader interested in more 
detail should consult either the tax law 
and regulations or references such as 
those in the reference section of this 
report (J^-2, 5), A brief section con- 
taining definitions of exploration and 
development precedes the tax discussion; 
definitions of other terms are in the 
appendix. 

Some repetition of material in the fol- 
lowing discussions, especially in the 
part on the current tax treatment of 
exploration and development costs, is 
necessary to keep each section self- 
contained. In addition, the parallel 
discussions are useful in highlighting 
the similarities and differences in the 
treatment of each of these costs. 



EXPLORATION AND DEVELOPMENT — DEFINITION OF TERMS 



DeYoung and Singer (_3, pp. 940, 944- 
945) identify six stages in the mineral 
supply process: exploration, develop- 
ment, mining (production), crushing and 
concentrating, smelting, and refining. 
Only the first three of these stages per- 
tain to this paper, and the discussion in 
this section is limited to them. 

These stages are sequential in that 
some results in each one are necessary 
for an advance to the following stage (3^, 
p. 945). For example, a mineral deposit 
must be discovered (result of explora- 
tion) before it can be prepared for com- 
mercial production (development) . On the 
other hand, the stages may overlap if 
further exploratory efforts are made at 
the same time that development work is 
being pursued. For tax purposes, the 
distinction between the exploration and 
development stages is important because 
the tax treatment of the expenditures as- 
signed to these respective categories 
differs significantly. 



A definition of exploration is implied 
in the Internal Revenue Code, which 
defines exploration expenditures as 
those expenditures for "...the purpose 
of ascertaining the existence, location, 
extent, or quality of any deposit of 
ore or other mineral, and paid or in- 
curred before the beginning of the de- 
velopment stage of the mine, . . ."(10, 
sec. 617). Thus, for tax purposes, the 
definition of exploration is based on 
the stage of the mineral supply process. 
Any exploration-type expenditures, such 
as for core drilling, made after the 
start of the development stage are con- 
sidered to be development expenditures 
(U p. 2002). 

Development is essentially the prepara- 
tion of a mineral deposit for commercial 
production after its existence has been 
determined by exploration. More detail 
of this activity can be obtained from 
the following definition of development 
expenditures. 



A rather comprehensive definition of 
exploration is given in Part 229, Chapter 
II, Title 30 (Mineral Resources) of the 
Code of Federal Regulations, which deals 
with obtaining federal financial assist- 
ance for mineral exploration. 

'Exploration' means the search, 
including related development 
work, for new or unexplored min- 
eral deposits within a specified 
area or parcel of ground where 
geologic conditions favor their 
occurrence. Exploration using 
recognized and sound procedures , 
including standard geophysical 
and geochemical methods , may be 
conducted from the surface or un- 
derground to obtain information. 
The work shall not go beyond a 
reasonable delineation and samp- 
ling of a mineral deposit, and 
shall not be conducted primarily 
for mining or preparation for 
mining. 



Mine development costs consist of 
those expenditures necessary to 
gain access to orebodies in the 
preproduction stage and to extend 
production in an existing ore- 
body, including costs for remov- 
ing overburden, sinking shafts, 
extending tunnels, and other ex- 
penditures that will be of no 
value after the exhaustion of the 
orebody (5^, p. 35) . 

Development expenditures are not de- 
fined in the Internal Revenue Code, but 
instead are referred to as "all ex- 
penditures paid or incurred during the 
taxable year for the development of a 
mine or other natural deposit (other 
than an oil or gas well) if paid or 
incurred after the existence of ores 
or minerals in commercially marketa- 
ble quantities has been disclosed" ( 10, 
sec. 616). Unlike the sharp tax dis- 
tinction made between expenditures in 
the exploration and the development 



stages, development expenditures may be 
incurred in both the development and 
production stages. The tax treatment 
of development expenditures and operat- 
ing (production) expenditures does dif- 
fer, but not as significantly as between 
exploration and development expenditures. 
The following diagram summarizes the re- 
lationship between the three stages and 
the assignment of expenditures for tax 
purposes. 



Expenditures 



Exploration 
Development 
Production 



Stage of the Mineral 
Supply Process 



-^ Exploration. 
-> Development. 
^ Production. 



In short, exploration expenditures can be 
incurred only in the exploration stage, 
and development expenditures can be in- 
curred in both the development and pro- 
duction stages. 



CURRENT TAX TREATMENT OF EXPLORATION AND DEVELOPMENT EXPENDITURES3 



EXPLORATION EXPENDITURES 

In general, a corporate taxpayer can 
deduct as incurred 85 pet (80 pet after 
1984) of the domestic exploration expend- 
itures. The other 15 pet (20 pet after 
1984) is to be capitalized and recovered 
over a period and at a rate equivalent to 
that for 5-year property under the Accel- 
erated Cost Recovery System. The alter- 
native is to capitalize the exploration 
expenditures and recover them through the 
depletion allowance. 

The general provision allowing the ex- 
pensing of exploration costs is contained 
in section 617 of the Internal Revenue 
Code, "Deduction and Recapture of Certain 
Mining Exploration Expenditures." Sec- 
tion 291 of the code, "Special Rules Re- 
lating to Certain Corporate Preference 
Items," contains the provision that lim- 
its the expensed amount to 85 pet (80 pet 
after 1984). It should be noted that 
section 617 does not refer to the limita- 
tion imposed by section 291, which was 
added by the Tax Equity and Fiscal Re- 
sponsibility Act of 1982. 

Oil and gas exploration expenditures 
are not covered by section 617, nor are 
exploration expenditures deductible for 
any mineral not eligible for the percent- 
age depletion allowance. Thus, materials 
such as soil, water, or minerals from sea 
water are not included. Costs that are 
deductible as incurred under other pro- 
visions of the code, such as State and 
local taxes, are not to be deducted as 
exploration expenditures. Further, the 



costs of items subject to a depreciation 
allowance cannot be immediately deduct- 
ed. Deductions to recover these costs 
must be made over time, subject to the 
tax rules for depreciation. The depreci- 
ation deduction that is available, how- 
ever, is considered to be an exploration 
expenditure. 

The expensing of expenditures for ex- 
ploration outside of the United States is 
limited to a maximum of $400,000. This 
is a total per taxpayer limit, and the 
maximum is reduced by any exploration 
expenditures, domestic or foreign, pre- 
viously expensed. Therefore, except to 
a very limited extent, foreign explo- 
ration expenditures are to be capital- 
ized and recovered through the depletion 
allowance. 

A provision known as recapture lessens 
some of the tax benefit of expensing ex- 
ploration costs. Exploration expendi- 
tures associated with a particular ef- 
fort, which are expensed, are subject to 
recapture when the producing stage is 
reached. Recapture takes place either by 
adding the previously expensed costs to 
gross income or by forgoing the depletion 
deduction until the amount forgone is 
equal to the total of the expenditures 
that were deducted. If the former choice 
is taken, the amount recaptured is added 

^The percent of exploration and devel- 
opment expenditures that cannot be ex- 
pensed was increased to 20 pet from 15 
pet, effective after 1984, by the Deficit 
Reduction Act of 1984. 



to the basis of the property and recover- 
able through the depletion allowance. 

Section 291 (b) of the Internal Revenue 
Code, effective for tax years starting in 
1983, provides that the immediate deduc- 
tion for exploration expenditures under 
section 617 be reduced by 15 pet (20 pet 
after 1984). In other words, 85 pet (80 
pet after 1984) of the exploration ex- 
penditures still may be deducted as in- 
curred. The 15 pet (20 pet after 1984) 
is to be capitalized and may be written 
off according to the following schedule, 
which is equivalent to that for 5-year 
property under the Accelerated Cost Re- 
covery System. 



Year 



Percent deducted 



1st 


15 


2d 


22 


3d 


21 


4th 


21 


5th 


21 


Total 


100 



The capitalized 15 pet (20 pet after 
1984) also qualifies for the investment 
tax credit. 

Finally, there are a couple of explora- 
tion cost tax provisions that apply only 
to individuals as opposed to corpora- 
tions. Section 57 of the Code, "Items of 
Tax Preference," lists exploration costs 
as an item of tax preference for noncor- 
porate taxpayers for purposes of the min- 
imum tax. The deduction under section 
617 is a tax preference item in a given 
year to the extent that it is greater 
than the amount that would have been de- 
ducted if the costs were deducted over a 
10-year period. Section 58 gives the 
individual taxpayer the option of deduct- 
ing exploration costs over a 10-year per- 
iod; the deduction for exploration costs 
then would not be subject to the minimum 
tax. 

DEVELOPMENT EXPENDITURES 

A corporate taxpayer can deduct as in- 
curred 85 pet (80 pet after 1984) of de- 
velopment expenditures. The remaining 15 
pet (20 pet after 1984) is to be capital- 
ized and recovered over a period and at a 



rate equivalent to that for 5-year prop- 
erty under the Accelerated Cost Recovery 
System. An option is to defer the devel- 
opment costs and deduct them ratably over 
time with the sales of the affected min- 
eral. If this option is selected, only 
the expenditures greater than net re- 
ceipts can be deferred while the mine is 
in the development stage. 

The general provision allowing the im- 
mediate deduction of development costs is 
contained in section 616 of the Internal 
Revenue Code, "Development Expenditures." 
Section 291 of the code, "Special Rules 
Relating to Certain Corporate Preference 
Items," contains the provision that lim- 
its the deduction to 85 pet (80 pet after 
1984) . Section 616 does not refer to the 
limitation imposed by section 291, which 
was added by the Tax Equity and Fiscal 
Responsibility Act of 1982. 

Oil and gas development expenditures 
are not covered by section 616. Costs 
that are deductible as incurred under 
other provisions of the code, such as 
State and local taxes, are not deductible 
as development expenditures. The costs 
of items subject to a depreciation allow- 
ance cannot be expensed, but these costs 
must be recovered over time, subject to 
the tax rules for depreciation. The de- 
preciation expense, however, is consid- 
ered to be a development expenditure. 

Section 291 (b) of the Internal Revenue 
Code, effective for tax years beginning 
in 1983, provides that the immediate 
deduction for development expenditures 
under section 616 be reduced by 15 pet 
(20 pet after 1984). This 15 pet (20 pet 
after 1984) is to be capitalized and 
written off according to a schedule 
equivalent to that for 5-year property 
under the Accelerated Cost Recovery Sys- 
tem (the same schedule shown earlier un- 
der Exploration Expenditures). The capi- 
talized 15 pet (20 pet after 1984) also 
qualifies for an investment tax credit. 

Finally, there are a couple of develop- 
ment cost tax provisions that apply only 
to individuals, as opposed to corpora- 
tions. Section 57 of the code, "Items of 
Tax Preference," lists development costs 



as an item of tax preference for noncor- 
porate taxpayers for purposes of the min- 
imum tax. The deduction under section 
616 is a tax preference item to the ex- 
tent that it is greater than the amount 
that would have been deducted if the 



costs were deducted ratably over a 10- 
year period. Section 58 gives the indi- 
vidual taxpayer the option of deducting 
development costs over a 10-year period; 
the deduction of development costs would 
then not be subject to the minimum tax. 



MAJOR CHANGES IN THE FEDERAL TAX TREATMENT OF EXPLORATION 
AND DEVELOPMENT EXPENDITURES 



This section details the major changes 
in the tax treatment of exploration and 
development costs since 1951. The rea- 
sons for the changes , as stated in the 
reports of the House Ways and Means and 
the Senate Finance Committees, are given. 
In addition, an analysis of the changes 
based on the general economic conditions 
and the status of the mineral industries 
at the time of the more significant 
changes is provided. The general status 
of the mineral industries is shown by 
aggregate measures, but the conditions 
for individual companies and minerals 
will often vary considerably, 

PRIOR TO 1951 

Prior to the Revenue Act of 1951, ex- 
ploration expenditures that resulted in 
production had to be capitalized and re- 
covered through the depletion allowance. 
Exploration expenditures for unsuccessful 
efforts could be deducted as losses. 
During the development stage, development 
expenditures in excess of net receipts 
were to be capitalized and recovered 
through the depletion allowance. During 
the production stage, development expend- 
itures were generally deductible as 
incurred. However, extraordinary expend- 
itures were treated as prepaid expenses 
and had to be deferred and deducted 
ratably over time with sales ( 16 , pp. 25- 
26, 43). 

1951: PUBLIC LAW 18 3-8 2nd CONGRESS 
(REVENUE ACT OF 1951) 

The Revenue Act of 1951 followed two 
other revenue-raising acts, the Revenue 
Act of 1950 and the Excess Profits Act of 
1950. Justification for these measures 
was provided in the House Ways and Means 
Committee report on the 1951 Act, which 



stated that "The military action in 
Korea, coupled with the general threat to 
world peace, has made it necessary to 
provide extraordinary increases in reve- 
nue to meet essential national defense 
expenditures" (23, p. 1). However, the 
tax changes related to exploration and 
development expenditures were revenue- 
reducing, rather than revenue-increasing, 
provisions. 

By adding subsection "ff" to section 23 
of the Internal Revenue Code of 1939, 
the 1951 Revenue Act provided that a tax- 
payer could deduct as incurred explora- 
tion expenditures up to $75,000 per year 
for any 4 years, or a total of $300,000. 
This provision specifically excluded 
items that were subject to depreciation 
under the tax law. However, the allowed 
depreciation deduction for such items was 
to be considered part of the exploration 
expenditures. Expenditures in excess of 
the dollar limitations were to be capi- 
talized and recovered through the deple- 
tion allowance. As an alternative to ex- 
pensing the exploration expenditures, the 
taxpayer could defer the costs and deduct 
them ratably over time with sales. The 
dollar limitations were the same regard- 
less of the option, or combination of 
options, chosen. 

The same act, by adding subsection "cc" 
to section 23 of the Internal Revenue 
Code of 1939, provided for the immediate 
deduction of development expenditures re- 
gardless of whether such expenditures 
were made in the development or produc- 
tion stage. The deduction was not al- 
lowed for items subject to depreciation 
under the tax law, but the depreciation 
allowances were to be considered develop- 
ment expenditures. As an alternative to 
expensing, the taxpayer could defer 



the development expenditures and deduct 
them ratably over time with sales of the 
affected minerals. Development expendi- 
tures made during the development stage 
had to be in excess of net receipts be- 
fore they could be deferred; in other 
words, an amount up to net receipts had 
to be deducted as incurred. 

The Revenue Act of 1951 was primarily a 
revenue-increasing measure. The Report 
of the Senate Finance Committee explained 
why the provision for the expensing of 
some exploration costs, which would re- 
duce tax revenue, was included in the 
act. First, the report stated that the 
Nation's mineral supply position was not 
adequate for meeting the demands of the 
economy, "especially in an emergency 
period..." (2_9, p. 63). Second, the re- 
port pointed out that exploration expend- 
itures were recovered through the deple- 
tion allowance, but the form of depletion 
commonly used (percentage depletion) was 
based on gross income. Thus, there was 
no special incentive for making explora- 
tion outlays. The Senate report provided 
essentially the same two arguments for 
the expensing of development expendi- 
tures. In addition, the disparity in the 
tax treatment of development expenditures 
in the development and production stages 
was considered undesirable because they 
were "essentially similar" (29, pp. 43- 
45, 63). ~ 

1954: PUBLIC LAW 591, 83RD CONGRESS 
(INTERNAL REVENUE CODE REVISION) 

In 1954, the Congress undertook a major 
revision of the Federal tax laws that re- 
sulted in the Internal Revenue Code of 
1939 being replaced by the Internal Reve- 
nue Code of 1954. The 1954 code, as 
amended, remains in effect. The major 
purposes of the revision were to arrange 
the provisions of the code in a more log- 
ical manner and to make them more under- 
standable. One result of this effort was 
the creation of Subchapter I (sections 
611-638), which deals exclusively with 
natural resources, especially minerals. 
An additional purpose of the code revi- 
sion was "to reduce tax barriers to fu- 
ture expansion of production and employ- 
ment" (21, p. 1). 



The restructuring of the code resulted 
in new section numbers 615 (repealed in 
1976) and 616 being assigned to the tax 
treatment of exploration costs and devel- 
opment costs, respectively. More im- 
portant, however, a Senate amendment, 
which the House agreed to in conference, 
provided for increases in the limits on 
the amount of exploration expenditures 
that could be expensed or deferred and 
deducted ratably to $100,000 annually and 
$400,000 overall (J_9, p. 53). The Senate 
Finance Committee Report contained no 
comment or reason other than acknowledg- 
ing that this action had been taken ( 27 , 
p. 80). The 4-year time limitation still 
held. 

1960: PUBLIC LAW 86-594 

The only purpose of Public Law 86- 
594, passed in 1960, was to remove the 
4-year limitation during which explora- 
tion expenditures could be expensed or 
deferred. The limits of $100,000 annual- 
ly and $400,000 in total per taxpayer re- 
mained in effect. 

Senate Finance Committee and House Ways 
and Means Committee reports noted that 
the 4-year limit discriminated against 
small mineral producers who might be mak- 
ing less than $100,000 of exploration 
outlays in any one year. These producers 
would never get to expense the total al- 
lowable limit of $400,000, but larger 
operators with annual exploration expend- 
itures of $100,000 or more would always 
be able to make full use of the immediate 
deduction. By removing the 4-year limi- 
tation, the small producers eventually 
might expense the total limit of $400,000 
per taxpayer ( 20 , 28) . 

1966: PUBLIC LAW 89-570 

Public Law 89-570, which dealt only 
with exploration outlays and which added 
section 617 to the Internal Revenue Code 
of 1954, provided for the expensing with- 
out limit of expenditures made for ex- 
ploration in the United States (including 
the Outer Continental Shelf) ; in other 
words, the $100,000 annual and $400,000 
total limitations were removed. However, 
once the producing stage of a mine was 



reached, the amount so deducted had to be 
recaptured. Recapturing was to be either 
by adding the amount of the previous ex- 
ploration deductions to income or by for- 
going the depletion deduction until the 
depletion deduction forgone was equal to 
the exploration deductions. The taxpayer 
still retained the option of deducting 
domestic exploration expenditures under 
section 615 of the code. Section 615, 
while having the disadvantage of the dol- 
lar limitation, had the advantage of not 
providing for recapture. Section 615 
still applied to foreign exploration 
expenditures. 

The House Ways and Means Committee and 
Senate Finance Committee reports (_1_8, pp. 
1-3; ^, pp. 1-3) contained several rea- 
sons for liberalizing the tax treatment 
of exploration expenditures. First, the 
tax incentive for exploration was quite 
limited under the current law because 
many mineral producers had reached the 
$400,000 limit, which could be deducted 
immediately or deferred and deducted 
ratably with sales. Second, the writeoff 
for unsuccessful expenditures, available 
upon the abandonment or disposal of the 
property, was not available much of the 
time. Mineral properties were frequently 
kept in anticipation of successful ex- 
ploration activity in the future or of 
the availability of techniques to utilize 
lower grade ores more efficiently. Both 
committees maintained that "these re- 
strictive effects of present law on ex- 
ploration expenditures are undesirable." 

1969: PUBLIC LAW 91-172 
(TAX REFORM ACT OF 1969) 

The House Ways and Means Committee and 
the Senate Finance Committee reports on 
the Tax Reform Act of 1969 described it 
as a "substantive and comprehensive re- 
form of the income tax laws" (24, p. 1; 
31 , p. 1). It was stated that numerous 
tax preferences had been enacted over the 
years and that the situation in this 
regard had gotten out-of-hand. A more 
fair distribution of the tax burden was 
deemed essential. The Ways and Means 
Committee bill contained 27 and the 
Finance Committee bill 34 "groups of tax 



reform provisions," and in each bill one 
group was natural resources. 

One of the numerous provisions enacted 
provided that the recapture rules apply 
to all mineral exploration expenditures 
that are expensed: There would no longer 
be the limited deduction as incurred 
without recapture under section 615. The 
title of section 615 became "Pre-1970 ex- 
ploration expenditures," and the limita- 
tion of $400,000 per taxpayer for foreign 
exploration expenditures was included in 
section 617. 

The committee reports stated specific 
reasons for making all expensed explora- 
tion outlays subject to recapture, in 
addition to the ones for general tax re- 
form. First, most affected taxpayers 
used the unlimited deduction with recap- 
ture. Second, the Committees, while ac- 
cepting the incentive aspect of expensing 
exploration expenditures, viewed the de- 
duction without recapture combined with 
the percentage depletion allowance as un- 
necessary "to provide the desired incen- 
tive" to undertake mineral activities 
(24, p. 143; 21)- 

1976: PUBLIC LAW 94-455 
(TAX REFORM ACT OF 1976) 

The basic objectives of the Tax Reform 
Act of 1976 related to equity, simpli- 
fication, and economic growth. As a 
result of the simplification process, 
section 615, "Pre-1970 exploration ex- 
penditures," was repealed. This sectioti 
was 1 of nearly 150 sections of the In- 
ternal Revenue Code repealed under "Title 
XIX — Repeal and Revision of Obsolete, 
Rarely Used, etc. , Provisions of Internal 
Revenue Code of 1954" of the 1976 Act be- 
cause they were no longer significant for 
tax purposes ( 25 , pp. 3, 385; 32^, pp. 2, 
506). 

1982: PUBLIC LAW 97-248 (TAX EQUITY 
AND FISCAL RESPONSIBILITY ACT OF 1982) 

The Tax Equity and Fiscal Responsibil- 
ity Act of 1982 contained numerous provi- 
sions affecting a wide range of tax- 
payers. The main objectives of the act 



related to revenue raising, increasing 
equity among taxpayers, eliminating dis- 
tortions in economic behavior caused by 
the tax system, and allocating the cost 
of government services to users. One of 
the approaches to achieving, at least 
partially, several of these broad objec- 
tives was a 15 pet reduction in selected 
tax preferences for corporations. One of 
the selected tax preferences was the ex- 
pensing of exploration and development 
costs. 

The 1982 act provided for a reduction 
in the allowable immediate deduction for 
exploration and development costs to 85 
pet of such costs. The remaining 15 pet 
is capitalized and may be written off 
over 5 years. The capitalized portion of 
exploration and development expenditures 



qualifies for the investment tax credit. 
These changes, along with the reductions 
in the other selected tax preferences, 
are contained in section 291 of the 
Internal Revenue Code and are not men- 
tioned in sections 616 and 617. 

Three reasons for the reduction in tax 
preferences were given in the Senate 
Finance Committee report. First, the 
large budget deficits warrant cutbacks in 
tax preferences as well as in direct 
spending. Second, the Accelerated Cost 
Recovery System, enacted in 1981, pro- 
vides a considerable incentive for in- 
vestment, and this makes other incentives 
less necessary. Third, the equity of the 
tax system is enhanced by such a measure 
(30, p. 118). 



ANALYSIS OF CHANGES 



The following tabulation summarizes the 
changes in the tax treatment of explora- 
tion and development expenditures. 

Prior to 1951: 

Exploration — capitalized. 
Development: 

Development stage — capitalize 

amount in excess of net receipts. 
Production stage — expense or, if 
extraordinary, defer and deduct 
ratably over time with sales. 
1951: 

Exploration — expense $75,000 annually 

for 4 years. 
Development — expense. 
1954: Exploration — expense $100,000 

annually for 4 years. 
I960: Exploration — no longer a 4-year 

limit. 
1966: Exploration — expense without 

limit but with recapture. 
1969: Exploration — no longer a limited 
($400,000) deduction without 
recapture. 
1976: Exploration — repealed obsolete 
provision of limited deduction with- 
out recapture. 
1982: Exploration and Development — 
reduced the amount that can be ex- 
pensed by 15 pet. 



Since 1951, the only major change in the 
Federal income tax treatment of mineral 
development expenditures has been that in 
1982. Changes in the tax provisions 
affecting exploration expenditures were 
more frequent and occurred in 1951, 1954, 
1960, 1966, 1969, 1976, and 1982. Of 
course, these changes varied considerably 
in their significance. Although there 
are too few observations to establish a 
definite trend, it may be noted that the 
tax treatment of these costs was liberal- 
ized in the four changes between 1951 and 
1966, and made more restrictive in the 
two substantive changes between 1969 and 
1982. 

The most significant changes in the tax 
treatment of mineral exploration and de- 
velopment expenditures occurred in 1951, 
1966, 1969, and 1982. (Only exploration 
expenditures were affected in 1966 and 
1969.) The 1969 change, while not im- 
portant in an absolute sense, indicated a 
reversal in direction from more liberal 
to more restrictive tax treatment. The 
1966 change is the only one of the four 
most significant changes that was the 
subject of a law itself; the other three 
changes were incorporated as part of 
larger tax measures. 



In 1950 and 1951, the U.S. mineral 
industries were operating at high levels 
of capacity due to "the high level of 
employment and demand sustained by the 
Korean War and by the general progress of 
the economy" {]_, p. 1). Profitability, 
measured by profits after income taxes as 
a percent of stockholders' equity, in the 
mineral-related industries (iron and 
steel, nonferrous metals, stone, clay, 
and glass) was generally above the aver- 
age for all manufacturing industries dur- 
ing 1950 and 1951 (13). The national in- 
come originating in metal and nonraetal 
(excluding fuels) mining, a quantitative 
measure of the economic importance of 
mining in the economy, was about 0.49 pet 
of total national income in both 1950 and 
1951 (^4). 

In addition, there was concern about 
mineral shortages. The Paley Commission 
was established in early 1951 and issued 
its report in June of 1952 (J_2 ) . One of 
the Commission's recommendations was that 
exploration costs be currently deductible 
without limit, a change not enacted until 
1966. It is noteworthy, also, that the 
Revenue Act of 1951, primarily a revenue- 
raising measure, contained revenue- 
reducing provisions with regard to ex- 
ploration and development costs. 



nonferrous metals was 8-pct below the 
all-manufacturing average in 1965, but in 
1966 had increased to 10 pet above it 
(13) . The national income originating in 
nonfuel mining, as a percent of total 
national income, was appproximately 0.35 
pet in both 1965 and 1966, down consid- 
erably from the figure of 0.49 pet in 
both 1950 and 1951 ( j^) . 

The first negative (to mining) change 
in the tax treatment of exploration costs 
occurred in 1969 as part of tlie Tax Re- 
form Act of 1969. This change was sig- 
nificant in that it signaled a new direc- 
tion for this mineral tax provision. The 
profit rates for the mineral-related in- 
dustries in 1968 and 1969 were mixed when 
compared to the all-manufacturing aver- 
ages. The profit rates for the iron and 
steel and the stone, clay, and glass in- 
dustries remained below the average, as 
they had for nearly the whole decade. 
The only exception was in 1960 when the 
profit rate for stone, clay, and glass 
was slightly above the all-manufacturing 
average (13). The national income origi- 
nating in nonfuel mining, as a percent of 
total national income, was about 0.29 pet 
in both 1968 and 1969, down significantly 
from both the 1950-51 and 1965-66 levels 
(14). 



In 1965 and 1966, as in 1950 and 1951, 
the mineral industries were performing 
quite well in the generally favorable 
economic conditions. The 1966 Bureau of 
Mines Minerals Yearbook recorded that 
"a booming economy, with rising consumer 
demand at home and the pressures on sup- 
ply from the Viet Nam war, strained pro- 
duction capacity in many of the mineral 
and mineral fuel industries in 1966" 
(9^, p. 24). Profit rates in the mineral- 
related industries, relative to the all- 
manufacturing averages , were mixed in 
1965 and 1966. Iron and steel profit 
rates were below the average, as they 
had been since 1958. The profit rate for 



The latest negative change occurred in 
1982, a dismal year for the mineral in- 
dustries. Profitability in all three of 
the mineral-related industries was below 
the all manufacturing average during both 
1981 and 1982. More significantly, the 
iron and steel and the nonferrous metals 
industries suffered losses in 1982 (13) . 
The value of U.S. nonfuel mineral produc- 
tion in constant (1972) dollars had 
reached a peak in 1979 and then dropped 
in 1980, 1981, and 1982. The national 
income originating in mining, as a per- 
cent of total national income, was 0.29 
pet in 1981 and 0.24 pet in 1982 (15). 



SUMMARY AND CONCLUSIONS 



Any conclusions drawn from the above 
analysis must be interpreted with a con- 
siderable degree of caution for several 



reasons. First, the provisions dealing 
with exploration and development expendi- 
tures are only a small part of the total 



ww^aMi o mwu i uinw 



HNyuLvoun 



11 



tax law. Because of other changes in the 
tax law, it cannot be definitively stated 
that the total Federal income tax burden 
on the mineral industries changed in ac- 
cordance with the change in the provi- 
sions related to exploration and develop- 
ment costs. Second, no attempt is made 
to establish causal relationships with 
the information in this report. There 
are too few observations and too many- 
factors involved in determining both tax 
policy and conditions in the mineral in- 
dustries to warrant speculation on causal 
relationships. However, some generaliza- 
tion is possible. 

The two positive changes in the tax 
treatment of exploration and development 



expenditures, in 1951 and 1966, are as- 
sociated with times when the Nation was 
engaged in military actions and the econ- 
omy, including the mineral industries, 
was expanding. Congressional reports in- 
dicated an interest in expanding miner- 
al production. The latest changes, in 
1969 and 1982, were restrictive and were 
part of major acts concerned with tax 
reform and equity. In 1982, conditions 
in the mineral industries were severely 
depressed. This more restrictive tax 
treatment for exploration and development 
expenditures is also associated somewhat 
with the relative decline in national in- 
come originating in mining. 



REFERENCES 



1. Burke, F. M. , Jr., and R. W. Bow- 
hay. Income Taxation of Natural Re- 
sources. Prentice-Hall, 1984, 31 ch. 

2. Coopers and Lybrand. Mining Taxa- 
tion: A Global Survey. 1983, 66 pp. 



1950. Ch. in BuMines 
1950, V. 1, pp. 1-28. 



Minerals Yearbook 



9. Morrison, W. E. Review of the 
Mineral Industries. Ch. in BuMines Min- 
erals Yearbook 1966, v. 1-2, pp. 1-76. 



3. DeYoung, J. H. , Jr., and D. A. 
Singer. Physical Factors That Could 
Restrict Mineral Supply. Econ. Geol. , 
75th Anniversary Volume, 1981, pp. 939- 
954. 

4. Hoffman, W. H. , Jr., and E. Willis 
(eds.). West's Federal Taxation: Com- 
prehensive Volume, 1983 Annual Edition, 
West Pub. , 1983, 1104 pp. 

5. Janson, E. C, S. C. Knup , and 
D. T. Wright. Financial Reporting and 
Tax Practices in Nonferrous Mining. 
Coopers and Lybrand, New York, 10th ed. , 
1981, 148 pp. 

6. Johnson, E. E. , and P. N. Yasnow- 
sky. Review of the Mineral Industries. 
Ch. in BuMines ^-linerals Yearbook 1965, 
v. 1, pp. 1-33. 

7. McGann, P. W. Review of the Min- 
eral Industries in 1951. Ch. in BuMines 
Minerals Yearbook 1951, v. 1, pp. 1-32. 



10. Prentice-Hall, Inc. Federal Tax 
Guide, Code Volume. Internal Revenue 
Code of 1954. 1977 (looseleaf , with up- 
dated suppl. ) . 

11. . Federal Tax Guide, Regula- 
tions Volumes (2). Income Tax Regula- 
tions. 1983 (looseleaf with updated 
suppl. ) . 

12. President's Materials Policy Com- 
mission. Resources for Freedom. V. 1, 
Foundations for Growth and Security, June 
1952, 184 pp. 

13. U.S. Bureau of the Census. Quar- 
terly Financial Report for Manufacturing, 
Mining, and Trade Corporations. Quarter- 
ly, 1950-83. 

14. U.S. Bureau of Economic Analysis 
(Dep. Commerce). The National Income and 
Product Accounts of the United States, 
1929-76, Statistical Tables. Sept. 1981, 
429 pp. 



8. McGann, P. W. , and L. L. Fisch- 15. 
man. Review of the Mineral Industries in ness. 



Survey of Current Busl- 



V. 63, No. 7, July 1983, p. 69. 



12 



16. U.S. Congress. Summary of the 
Provisions of the Revenue Act of 1951 
(H.R. 4473) As Agreed to by the Con- 
ferees. Joint Committee on Internal Rev- 
enue Taxation. Oct. 1951, 75 pp. 

17. U.S. General Accounting Office. 
Need To Develop a National Non-Fuel Min- 
eral Policy. RED-76-86, July 2, 1976, 
39 pp. 

18. U.S. House of Representatives. 
Income Tax Treatment of Exploration Ex- 
penditures in the Case of Mining. Com- 

-^mittee on Ways and Means. 89th Congr. , 
2d sess.. Rep. 1237, Feb. 1, 1966, 20 pp. 



19. 
1954. 



Internal Revenue Code of 



Conference Report To Accompany 
H.R. 8300. 83d Congr., 2d sess.. Rep. 
2543, July 26, 1954, 86 pp. 

20. . Limitation on Deduction of 

Exploration Expenditures. Committee on 
Ways and Means. 86th Congr., 1st sess.. 
Rep. 1054, Aug. 26, 1959, 4 pp. 

21. , Report of the Committee on 

Ways and Means To Accompany H.R. 8300, a 
Bill To Revise the Internal Revenue Laws 
of the U.S. 83d Congr,, 2d sess., Rep. 
1337, Mar. 9, 1954, 109 pp., plus append. 



22. 



Revenue Act of 1951. 



Conference Report To Accompany H.R. 
4473. 82d Congr., 1st sess.. Rep. 1179, 
Oct. 15, 1951, 109 pp. 



23. 



Revenue Act of 1951. Re- 



port of the Committee on Ways and Means. 
82d Congr. 1st sess.. Rep. 586, June 18, 
1951, 152 pp. 

24. . Tax Reform Act of 1969. 

Committee on Ways and Means. 91st 



Congr., 1st sess.. Rep. 91-413, pt. 1, 
Aug. 2, 1969, 226 pp. 



25. 



Tax Reform Act of 1976. 



Committee on Ways and Means. 94th 
Congr., 1st sess.. Rep. 94-658, Nov. 12, 
1975, 476 pp. 

26. U.S. Senate. Income Tax Treatment 
of Exploration Expenditures in the Case 
of Mining. Committee on Finance. 89th 
Congr., 2d sess.. Rep. 1377, July 19, 
1966, 21 pp. 



27. 



Internal Revenue Code of 



1954, Report of the Committee on Fi- 
nance. 83d Congr., 2d sess., Rep. 1622, 
June 18, 1954, 628 pp. 



28. 



Limitation on Deduction of 



Exploration Expenditures. Committee on 
Finance. 86th Congr., 2d sess.. Rep. 
1137, Feb. 24, 1960, 7 pp. 



29. 



Revenue Act of 1951. Re- 



port of the Committee on Finance. 82d 
Congr., 1st sess.. Rep. 781, Sept, 18, 
1951, 120 pp. 



30. 



Tax Equity and Fiscal Re- 



sponsibility Act of 1982. Committee on 
Finance. 97th Congr,, 2d sess,. Rep, 97- 
494, July 12, 1982, 434 pp. 



31, 



Tax Reform Act of 1969, 



Committee on Finance, 91st Congr, , 1st 
sess,, Rep, 91-552, Nov, 21, 1969, 
352 pp. 



32, 



Tax Reform Act of 1976. 



Committee on Finance. 94th Congr. , 2d 
sess.. Rep. 94-938, June 10, 1976, 
607 pp. 



13 



APPENDIX. —GLOSSARY 



Accelerated Cost Recovery System . — "An 
arbitrary means where the cost of tangi- 
ble property is recovered over a pre- 
scribed period of time. Enacted by the 
Economic Recovery Tax Act (ERTA) of 1981, 
the approach disregards salvage value and 
imposes a period of recovery that depends 
upon the classification of the asset" (_4, 
p. 995). 

Basis . — "The amount assigned to an as- 
set for income tax purposes. For assets 
acquired by purchase, basis would be 
cost." Adjusted basis is the "cost or 
other basis of property reduced by depre- 
ciation [or depletion] allowed or allowa- 
ble and increased by capital improve- 
ments" (A, pp. 997, 1000). 



and 22 depending on the mineral, of the 
gross income from the mineral property. 

Depreciation . — "The write-off for tax 
purposes of the cost or other basis of a 
tangible asset over its estimated useful 
life" (_4, p. 1007). 

Expensing . — The taking of a deduction, 
used in computing taxable income, immedi- 
ately (during the current tax period). 
Also referred to as "deducting as in- 
curred" or to "currently deduct." 



Investment 



tax credit. — A 



credit 

against the income tax liability equal to 
a specified percent of qualified invest- 
ment made by the taxpayer. 



Capitalize . — To treat an expenditure as 
an acquisition, or addition to the basis, 
of property, the cost of which is to be 
recovered over time through depreciation 
or depletion. 

Depletion . — A deduction in computing 
taxable income for the depletion of tim- 
ber and minerals. There are two methods 
of depletion computation authorized by 
Federal tax law: cost depletion and per- 
centage depletion. Cost depletion is 
computed by dividing the cost basis by 
the estimated reserves and then multiply- 
ing this figure by the annual sales in 
physical units. Percentage depletion, 
available only for minerals, is computed 
by taking a specified percent, between 5 



Minimum tax on items of tax prefer- 
ence . — A tax, enacted in 1969, to ensure 
that taxpayers whose taxable income was 
reduced due to certain deductions or to 
special treatment of certain types of in- 
come (tax preferences) would be liable 
for at least some (a minimum) tax. The 
minimum tax is levied in addition to the 
regular income tax. 

Ratably . — Same as proportionately. 

Recapture . — "To recover the tax benefit 
of a deduction or a credit previously 
taken" (A_, p. 1025). The recovery is by 
the tax authority of a benefit taken by 
the taxpayer. 



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